Document of THE WORLD BANK FOR OFFICIAL USE ONLY Report No.: 20253 PERFORMANCE AUDIT REPORT POLAND ENTERPRISE AND FINANCIAL SECTOR ADJUSTMENT LOAN (Loan 3599-POL) March 27,2000 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in th performance of their official duties. Its contents may not otherwise be disclosed withou World Bank authorization. Currency Equivalent (as of September 30, 1999) Currency Unit = Zloty (Z) US$1.00 = 4.1141 Zlotys ZI = US$0.2431 Average Exchange Rate Zlotys per US$1.00 1993 1994 1995 1996 1997 1998 1.8145 2.2727 2.4244 2.6965 3.2808 3.4937 Abbreviations and Acronyms BGZ The State Agricultural Bank EBRP Enterprise and Bank Rehabilitation Program ECA Europe and Central Asia Region EFSAL Enterprise and Financial Sector Adjustment Loan DDR Debt and Debt Service Reduction FIDL Financial Institutions Development Loan G24 The Group of 24 Developed Nations IF Intervention Fund MOF Ministry of Finance PAR Performance Audit Report PKO BP The State Savings Bank SOCB State-owned Commercial Banks SOE State-owned Enterprise SMEs Small and Medium-Scale Enterprises Director General, Operations Evaluation Mr. Robert Picciotto Director, Operations Evaluation Department Ms. Elizabeth McAllister Manager : Mr. Ruben Lamdany Task Manager : Mr. John H. Johnson FOR OFFICIAL USE ONLY The World Bank Washington, D.C. 20433 USA Office of the Director-General Operations Evaluation March 27, 2000 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Review on Poland Enterprise and Financial Sector Adjustment Loan (Loan 3599-POL) Attached is the Performance Audit Report (PAR) on the Poland Enterprise and Financial Sector Adjustment Loan for US$450 million, approved in 1993. The project closed on June 30, 1996, one year later than scheduled. Following a period of significant improvement in Poland's economy and public finances, the Borrower no longer required additional financing from the EFSAL. Therefore, at the Government's request, the planned third tranche of US$125 million was cancelled. Designed by the Government, the EFSAL addressed the systemic insolvency in the state-owned enterprises and the banks which had extended them credit. The EFSAL adopted an innovative approach for dealing with the structure of enterprise ownership and governance, which was adopted for use in three other transition economies. Specific objectives were to: (i) improve enterprise responsiveness and adaptation to market signals by facilitating the exit of nonviable enterprises and reorganizing state enterprises; and (ii) enforce financial discipline on enterprise debtors through mandatory out-of-court conciliation agreements, faster bank privatization and strengthened bank supervision. The EFSAL was highly successful, contributing significantly to the rapid recovery and transformation of the Polish economy. Nine state-owned commercial banks were privatized (though most after the EFSAL had closed), enterprise privatization goals were met, and the bank-led conciliation process for indebted enterprises proved effective. Bank workout capacity and supervisory oversight of their activities were substantially strengthened. As a result, Poland's financial sector now resembles that of a modern market economy. While there were some shortcomings, such as the weak design and execution of the Intervention Fund, the PAR accords greater weight to the highly innovative nature of the EFSAL, and its overall contributions to Poland's economic progress. Therefore, outcome is rated highly satisfactory. Sustainability is considered likely, in view of generally positive trends in macroeconomic and financial sector management. Institutional development impact is rated substantial, taking into account the strengthening of bank workout capacity and government banking oversight. Bank performance is rated satisfactory, based on the participatory approach to design of the project and effectiveness in aid coordination. These ratings all agree with those of the earlier Evaluative Summary. Borrower performance is rated highly satisfactory (compared to satisfactory in the Evaluative Summary), based on the Government's innovative project design and the major improvements in financial sector regulation. Key lessons include: (i) It pays to listen to the client, who in this case proposed a superior project design; (ii) The EFSAL was successful because it dealt simultaneously with the bad debt stock and the associated flow problems of enterprises; and (iii) Careful sequencing ensured that, before bank recapitalization occurred, the prerequisites for sustaining responsible bank behavior were put in place. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Contents Preface .............. i Ratings and Responsibilities ....................................................u 1. Background ..........................................................1 2. EFSAL Objectives and Design ................................... ..........1 3. Implementation .......................................................4 Achievements ......................................................4 Shortcomings ......................................................5 4. Outcome and Sustainability ...............................................7 5. Bank and Borrower Performance .................................. ..........7 6. Lessons Learned ....................................................... 8 ANNEXES A. Poland At A Glance .....................................................9 B. Basic Data Sheet...................................................... 11 C. Key Macroeconomic Variables, 1990-98...................................13 D. Comments of the Polish Government on the Audit ..................................14 This report was prepared by Luis Landau, Elliot Hurwitz and John Johnson (Task Manager). Betty Casely-Hayford provided administrative support.  1 Preface This is a Performance Audit Report (PAR) for the Polish Enterprise and Financial Sector Adjustment Loan (EFSAL), in the amount of US$450 million equivalent which was approved on May 4, 1993, and made effective on January 6, 1994. The loan was intended to provide an innovative vehicle for the resolution of the systemic insolvency of large, state-owned enterprises which owed large sums to state-owned banks. It was also designed to provide incentives for these banks to strengthen their portfolios, and help them build capacity in their workout units, prior to privatization. The EFSAL was one of two Bank loans in the financial sector-the other being the Financial Institutions Development Loan-which supported Poland's policy reforms under the Government's 1993 Enterprise and Bank Restructuring and Privatization Program. The loan's first tranche of US$125 million was disbursed on June 6, 1994, followed by a DDSR set-aside of US$100 million, disbursed on November 14, 1994,1 and a second tranche of US$100 million released on March 20, 1996. A planned third tranche was not utilized,2 and the balance of US$125 million was cancelled. The project closed on June 30, 1996, one year later than anticipated. This PAR is based on the Implementation Completion Report dated June 16, 1997, as well as interviews with project staff, project records, and material collected in conjunction with the Poland Country Assistance Review (June 1, 1997). In addition, an OED mission visited Poland in April 1998, and discussed the project with Government officials and representatives of civil society and other donors. The draft PAR was reviewed by the Government of Poland, whose comments of March 25, 2000 (attached as Annex D) are fully reflected in the final text. I The Bank committed US$400 million from tranches of various operations to support a successful London Club arrangement reached in March 1994 to restructure Poland's large debt to foreign private banks. 2 The third tranche was cancelled because, with the overall improvement in the economy and Poland's public finances, the country did not require the additional financing from the EFSAL. 11 Ratings and Responsibilities Performance Ratings Evaluation Summary PAR Outcome Highly Satisfactory Highly Satisfactory Sustainability Likely Likely Institutional Development Impact Substantial Substantial Bank Performance Satisfactory Satisfactory Borrower Performance Satisfactory Highly Satisfactory Key Project Responsibilities TM Division Chief Director Appraisal Olivier Godron Michel Noel Kemal Dervis Completion Hormoz Aghdaey Michel Noel Jean-Michel Severino ICR prepared by Michael Borish 1 1. BACKGROUND 1.1 By 1993-94, despite structural flaws, Poland's economy had begun to emerge from the macroeconomic instability that followed the end of its planned economy and the collapse of the CMEA trade regime (Annex C). Earlier Bank lending and technical advice had helped with initial steps in the transition and stabilization.' In addition, other donors provided assistance: the European Union/PHARE; the European Bank for Reconstruction and Development; United States Agency for International Development, which provided a US$1 billion stabilization fund; and the International Monetary Fund, which established a US$1.6 billion Extended Fund Facility. However, Poland still lacked many preconditions for private sector expansion, including a legal and institutional framework that could facilitate the exit of loss-making firms. 1.2 Enterprise Sector-By early 1994, the private sector was expanding rapidly after the stabilization of prices and external trade. However, most private sector growth was driven by the creation of new enterprises-not by the privatization and restructuring of large state-owned enterprises (SOEs). Privatized and restructured state enterprises-burdened by old operational procedures, lack of marketing experience, heavy debt, and outdated technology-lacked the dynamism to compete in new markets, and many faced a deepening crisis. Large loss-makers employed around 500,000-700,000 workers, often geographically concentrated ("company towns"). At the time of EFSAL effectiveness in January 1994, progress in reforming SOEs was disappointing. The pace of ownership and governance reforms was slow, and restructuring often proceeded in a haphazard manner. The Government anticipated enterprise requests for "rescue," and wisely preferred that these be addressed in a transparent manner. 1.3 Banking Sector-The portfolio of the state-owned banks consisted largely of loans to SOEs, and as their situation worsened, so did the banks' balance sheets. The magnitude of the crisis and its systemic nature would have taxed the normal "exit mechanisms" of even countries with a fully-developed market economy. However, such mechanisms in Poland were very limited. It was also clear to the Government that the potential risks of inaction, or misguided action, were large: higher unemployment, severe pressure for Government spending and subsidies, a threat to macroeconomic stability, and the fate of the entire reform process. 2. EFSAL OBJECTIVES AND DESIGN 2.1 Against this backdrop, it was clear to the Polish Government that decisive action was required to create a program that would: * Provide a clear and limited vehicle to ensure that the resolution of socially sensitive cases would be adequately funded in a transparent, but limited, manner * Provide a vehicle to resolve the systemic insolvency of the SOEs and the banking system, which would minimize economic costs and by-pass the banking system A Structural Adjustment Loan of US$300 million, approved in 1990, had bolstered the credibility of the country's reforms. Bank investment lending and technical advice were also helpful in building institutions for a market economy. 2 * Provide incentives for banks to strengthen their portfolios, improve their management and prepare for privatization. 2.2 The blueprint for this program was adopted by the Polish Government in 1993 in conjunction with the Enterprise and Bank Rehabilitation Program (EBRP), after consultation with the Bank and other partners.2 Following the development of EBRP, the Bank and the Government developed a financial sector strategy intended to stimulate sustained private sector growth and speed Poland's economic transformation. This was to be achieved by removing major policy constraints, and by strengthening the institutions required for financial intermediation in a market-based system. 2.3 The Financial Institutions Development Loan (FIDL) introduced in 1992 and the Enterprise and Financial Sector Adjustment Loan (EFSAL), approved in January 1994. As summarized in Table 1, these projects focused on: * Financial system modernization (FIDL and EFSAL) * Institutional strengthening and privatization of banks (FIDL and EFSAL) * Enterprise restructuring and privatization (EFSAL) Table 1: Main Provisions of FIDL and EFSAL FIDL EFSAL January 1992-December 1998 January 1994-June 1996 Objectives and Institutional development of banks, Strengthen bank workout capability Components including twinning with foreign partners Establishment of a deposit insurance Recapitalization of 7 state-owned scheme commercial banks Privatization of 6 of 9 state-owned Privatization of 2 of 9 state-owned commercial banks commercial banks, and significant progress toward privatizing remaining 7 Elimination of subsidized lending and Stimulate GOP action to meet enterprise directed credit privatization targets Adoption of revised Banking and Collateral Bank-managed restructuring of Laws enterprises Adoption of revised prudential Creation of Intervention Fund requirements Strengthened bank supervision 2.4 Specifically, the EFSAL was the Bank's principal financial vehicle supporting the policy reforms introduced by the EBRP. Designed_by the Government, the EFSAL addressed a root cause of the SOE crisis: the ineffective structure of enterprise ownership and governance. 2.5 During this period, the Bank, the International Monetary Fund, and other major donors organized a debt and debt-service reduction package covering Poland's massive debt to private foreign banks, which had been in default. A successful London Club arrangement was reached in March 1994, which the Bank 2 The Bank's proposal had been to create a "hospital" for bad loans, a separate agency empowered to absorb the bad loans, which, however, had the drawback of not building workout capacity in the banks. 3 supported with US$400 million (US$170 million from the Debt and Debt Service Reduction loan and US$230 million from funds set aside from three previously approved adjustment loans-of which US$100 million came from the EFSAL). The deal provided Poland with substantial debt relief and helped restore its creditworthiness and immediate access to international financial markets. 2.6 The EFSAL fostered a microeconomic response to the new environment created by the price and trade liberalization policies of the early 1990s. It was made possible by passage in February 1993 of legislation-the Law on Financial Restructuring of Enterprises and Banks-to facilitate enterprise restructuring. This innovative law encouraged banks to play a leading role in enterprise restructuring through out-of-court conciliation agreements. The project's primary objectives were to: (i) improve the enterprise sector's responsiveness and adaptation to market signals, facilitating the exit of nonviable enterprises; and (ii) raise the level and quality of financial intermediation through improved credit allocation and enhanced bank capacity to impart and enforce financial discipline on enterprise debtors. Enterprise Reform 2.7 The enterprise reform objective, in turn, was advanced by three main components: (i) reducing the debt overhang of the SOEs, while cleaning up the portfolios of the State-owned commercial banks (SOCBs). (ii) accelerating privatization of sound and potentially viable enterprises; and (iii) financing the creation of an Intervention Fund (IF) to act as a "shock absorber" for actions affecting key enterprises, mitigating the consequences of reorganization and downsizing. Strengthening Financial Intermediation 2.8 The EBRP legal framework linked bank recapitalization to improvements in operating systems. It revamped the enabling environment for commercial banks, through privatizing, strengthening prudential regulations, and enhancing supervision of their activities. The Bank also collaborated with the U.S. Treasury in setting up a Bank Privatization Fund, an offshoot of the G24 Stabilization Fund supporting the zloty against speculation. Once the zloty had been stabilized, about US$500 million from the Stabilization Fund was redirected into bank recapitalization under EFSAL. 2.9 Banks privatized or in the process of privatization were eligible for recapitalization after they had: It should be noted that the EFSAL dealt exclusively with the state-owned commercial banks, representing less than 25 percent of total banking sector assets. The Government took the position that the two other largest banks-BGZ, the agricultural bank, and PKO BP, the savings and mortgage bank-should not be dealt with separately, because their problems were qualitatively different from those of the SOCBs. 4 The EFSAL called for privatization of at least two of the nine state-owned commercial banks (SOCBs) by second tranche disbursement, and "significant progress toward privatization of the remaining banks" by third disbursement of the tranche. 4 * commissioned independent financial audits and portfolio reviews; * assigned their troubled assets to a separate organizational unit; and, * submitted to the MOF a strategic plan to deal with the troubled assets. 2.10 Finally, banks assumed leadership in restructuring enterprises through mandatory out-of-court conciliation agreements, mainly with larger enterprises, since SMEs were less likely to have large-scale bank obligations.' 3. IMPLEMENTATION Achievements 3.1 The preparation, design, and implementation of the EFSAL were innovative and highly successful, contributing to the rapid recovery and transformation of the Polish economy. The EFSAL dealt simultaneously with the SOE debt overhang and the portfolio problems of the banking system, whereas in earlier Bank financial sector loans, reform of the enterprise sector commenced only after bank recapitalization. In doing so, the EFSAL markedly reduced the expected frequency of financial crises. 3.2 Among the transition economies, Poland was a pioneer in linking recapitalization in this way to improvements in bank operating systems. The decentralized approach for working out bad loans was also pathbreaking, and was adapted for use in three other transition countries. Banks played a central role in enterprise restructuring, while enterprises gained new opportunities for successful reorganization. The conciliation process had mainly positive outcomes, building capacity in bank workout units, forcing otherwise passive creditors to take action against bad debtors, weeding out unviable firms.6 On average, conciliation took six to seven months, with agreement on restructuring plans adding another four months. Stronger firms qualified, while weaker ones were forced into bankruptcy or liquidation. 3.3 The structure of Poland's banking sector now resembles that of a modern market economy. An independent central bank is responsible for monetary policy, and a professional bank supervision department has been developed. By disbursement of the EFSAL second tranche, two commercial banks had been privatized (the other seven were privatized later), capital adequacy ratios of participating banks exceeded international standards, problem loans were fully provisioned, workouts had been actively pursued, and most banks enjoyed progressive and market-oriented management. Foreign banks have since entered the market, in many cases by acquiring Polish banks, fostering competition and modernization. Interest rate spreads are now significantly smaller, the scope and quality of financial services have markedly improved, and lending to enterprises has increased substantially, nearly doubling from 1994 to July 1999.8 The EFSAL also helped banks improve key business skills. s Enterprises included in the EFSAL were mainly large industrial firms in sectors other than mining, steel, shipbuilding, defense, and energy. See Cheryl Gray and Arnold Holle, "Bank-Led Restructuring in Poland," World Bank, Sept. 1996, and Simon Commander, "Enterprise Restructuring and Unemployment in Models of Transition," World Bank, April 1998. 7 See also Fernando Montes-Negret and Luca Papi, "The Polish Experience with bank and Enterprise Restructuring," World Bank, January 1997. 8 Calculated in US dollars. Data from Resident Mission, Warsaw. 5 3.4 As of late 1999, the financial sector was sound, with the possible exceptions of BGZ, the state agricultural bank, and PKO BP, the state saving bank. Approximately 65 percent of the equity (and a somewhat smaller proportion of the assets) in the financial sector is in private hands. Meanwhile, newly- created pension funds, a consequence of pension system reform, serve more than 8 million people and have helped deepen capital markets. 3.5 The EFSAL required at least 3,200 privatizations to be completed before third tranche disbursement. Although, this tranche never actually disbursed, this target was fully met by September 1996, with 2,714 direct privatizations, 512 companies placed into the Mass Privatization Program, and 180 "capital transactions," for a total of 3,406 enterprises privatized in accordance with the Privatization Law. Macroeconomic and Poverty Impact 3.6 The EFSAL contributed significantly to Poland's economic recovery. As shown in Annexes A and C, Poland's macroeconomic performance during and after implementation of the EFSAL improved significantly. From 1993 to 1998, real GDP expanded by nearly 34 percent, or 6.1 percent per year. Unemployment, after peaking in 1993 at 16.4 percent, declined to 9.5 percent in June 1998. By the end of 1998, the fiscal deficit was under 3 percent of GDP.9 Poverty data are not available for Poland, but there is evidence that income inequality increased less than in any transition country except Slovakia."o Poland also compares favorably with other ECA and upper-middle income countries in life expectancy, infant mortality, and literacy. Shortcomings 3.7 Shortcomings were noted in the operation of the Intervention Fund, the pace of bank privatization, and the design of conditionality among bank operations. The Intervention Fund (IF) 3.8 The Intervention Fund " was intended as a "shock absorber", an instrument for reducing the impact of restructuring or liquidating enterprises, whenever this would have been "exceptionally difficult from an economic or social standpoint". The IF was meant to be a "limited measure... with strong negative incentives for enterprises and banks to apply for public money" (see Box 1). However, not all IF operations have remained within the short-term, time-bound framework originally intended, in part because the legal provisions included no "sunset" clause. Had the IF included a condition that enterprises receiving budgetary support were required to be privatized (as opposed to commercialized), and had a sunset provision been included, this component would not have clashed with the intent of the overall reform program. A second issue concerns the use to which IF resources were put. Although the loan agreement called for an audit of the IF as a condition for the third tranche release, the Borrower cancelled the EFSAL before disbursement. Consequently, no audit was performed. Nor did the Bank avail itself of 9 Data through 1998 from OECD, and estimates for 1999 from Resident Mission, Warsaw. 1o The Gini coefficient increased by only 2 in Poland over this period compared with an increase of 3 in Slovenia, 11 in Estonia, and 23 in Russia. Grzegorz W. Kolodko, "Incomes Policy, Equity Issues, and Poverty Reduction in Transition Economies," Finance and Development, September 1999. A second study found that the Gini ratio in Poland (1993-95) was 28, compared to an average of 33 for all transition countries (other Central Europe, 24; Bulgaria and Romania, 32; Baltics, 34; "Slavic Republics and Moldova," 40; Central Asia, 39). Branko Milanovic, "Income, Inequality, and Poverty During the Transition from Planned to Market Economy," World Bank, February 1998. I1 US$ 125 million from the first tranche of the EFSAL was used to support the IF. Not including the DDSR set aside, spending on the IF comprised 56% of total EFSAL disbursements. 6 the option of performing an audit or review as part of its general authority. The IF remains in operation as of October 1999. 3.9 Supervision of the Intervention Fund was also inadequate. The original intent-in conjunction with the third tranche-to perform an external audit as part of a comprehensive review of the IF, was never fulfilled. After the third tranche was cancelled, Bank staff declined the option of conducting an audit under its general audit authority. Moreover, the Bank should have acted sooner and more forcefully when signs arose that the Intervention Fund was operating in ways not fully compatible with the privatization and restructuring goals of the EFSAL. Box 1: Criteria for Intervention Fund Eligibility * Budgetary support to a given enterprise was to be provided only once. * Restructuring or liquidation plans were to provide for divestiture of all non-productive assets, with wage and/or layoff provisions vetted by unions. * The eligible borrowing enterprise had have been commercialized. * SOE ownership rights to land and buildings had to have been clarified. * Evidence had to be provided that state budgetary resources had not been used to pay off other creditor claims. Delays in Bank Privatization 3.10 Bank privatization proceeded more slowly than expected. It was connected with the complicated process of the transformation of the Polish economy, which included problems with bad loans. A lack of precision in the EFSAL legal documents deprived the Bank of a clear mandate to monitor the pace of privatization12. Also, finding strategic investors proved difficult. By the EFSAL's second tranche, two of nine state-owned banks had been privatized, as agreed. The remaining state-owned banks were privatized in 1999. The privatization of the banks accelerated the development of the capital market and influenced changes in other sectors of the Polish economy. Terms Among Related Bank Lending Operations 3.11 The EFSAL was prepared and approved during 1992-93, when Poland's ability to finance its then large current account deficit was in doubt. Later Poland was able to generate strong capital account surpluses, thanks to a surge in net export earnings and inflows of foreign direct investment (see Annex C). The Government also viewed the loan as a strong external vote of confidence for its reform program. 3.12 Nonetheless, given the numerous sources of finance available at the time, Poland's need for a loan of this size (US$450 million), which came soon after receiving US$200 million from the FIDL, remains an open issue. Also, as shown in Table 2, there was substantial overlap in the conditionality of the two loans. Indeed, only one year after EFSAL approval, the Polish authorities were registering concern about the size of the Bank's commitment fees, expressing a preference for smaller, simpler Bank projects in the future focussed on social sector initiatives for which private funding was unlikely to be available. 12 See Poland Country Assistance Review, v. II, p. 24. 7 Table 2: Overlapping Conditionality in Lending to Poland Conditionaliy EFSAL FIDP $US450m SUS200m Macroeconomic Stabilization I Enterprise Reform/Restructuring/ Privatization Government Funding of Enterprises Bank Reform/Recapitalization/Privatization Strengthen Bank Supervision V Improve legal/regulatory framework for banking Bank Development and Strengthening Deposit Insurance Reform Banking Sector Policy Reform 4. OUTCOME AND SUSTAINABILITY Outcome 4.1 Outcome is judged to be highly satisfactory. Despite its shortcomings, the EFSAL convincingly achieved its main objectives, laying the foundation for a robust financial sector. Sustainability 4.2 Sustainability is judged as likely. The privatization of commercial banks is unlikely to be reversed; the banking and enterprise sectors have improved management and governance; and Poland is experiencing rising levels of financial intermediation. Poland's progress toward entering the European Union offers further evidence that the reforms achieved by the EFSAL are likely to be sustained. 5. BANK AND BORROWER PERFORMANCE Bank Performance 5.1 On balance, Bank performance was satisfactory. While the specification of the terms of conditionality could have been clearer, and the efficacy of supervision improved, the project was developed in a participatory manner; the Bank contributed materially to strengthen the project design; and the Bank was effective in coordinating activity with other donors. The Resident Mission played a key role in the launch of the reform program. Throughout, the Bank's work was made more difficult by several factors. The Polish experiment was new, and Bank staff had to respond quickly to unprecedented challenges in a continually changing environment. Abrupt changes in the Governmental line-up and policies disrupted the policy dialogue and, at times, program implementation. 8 Borrower Performance 5.2 Borrower performance was highly satisfactory in project design and in most aspects of implementation, particularly in the passage of necessary legislation, the establishment of effective policy and regulatory bodies, and the maintenance of a supportive macroeconomic framework. Enterprise privatization, although hesitant at certain points, was in line with EFSAL targets. And privatization of the nine SOCBs was achieved, albeit not within the expected time frame. Only with respect to administration of the Intervention Fund could it be said that Borrower performance fell short of satisfactory. Institutional Development 5.3 The project's institutional development impact was substantial. The bank supervision capacity of Poland's Central Bank was strengthened, as were the workout capabilities of the commercial banks. Poland's banking sector now resembles that of a modem economy, with bank management generally regarded as progressive and market-oriented. 6. LESSONS LEARNED 6.1 It pays to listen to the client. The design of the EFSAL was conducted in a participatory fashion. The Bank's initial concept for the project was entirely different from the eventual design. The core concept-linking bank recapitalization to enterprise restructuring/liquidation-was proposed by a small group of innovative Polish Government officials. Bank staff listened carefully, and ultimately agreed to these changes. 6.2 The EFSAL was comprehensive in addressing the insolvency problems of SOCB loans, dealing with the bad debt stock problem and the associated flow problem. It made assistance to the commercial banks contingent on the completion of concrete actions with respect to enterprises, including privatization or liquidation. Polish banks were not only recapitalized, but were helped in improving their credit assessment and risk control systems. The lesson is that improving banking skills and incentives helps ensure the success of bank recapitalization. 6.3 A key to EFSAL success was careful sequencing. Success required that bank recapitalization be started after other prerequisites for sustaining responsible bank behavior were in place, including an effective bank supervision function; measures to sanction abusive practices by banks; the ground-work for bank privatization and strong Borrower commitment to macroeconomic stabilization management. 6.4 Conditionality needs to be spelled out precisely in the legal convenants. The EFSAL's intended conditionality was weakened by the lack of precision in the legal documents. The Loan covenants failed to spell out adequately the Bank's mandate to monitor the agreed pace of privatization and to supervise adequately the operations of the Intervention Fund. Lack of timely involvement by Bank lawyers in the project design played a role. 9 Annex A Page 1 of 2 Poland at a glance Europe & Upper. POVERTY and SOCIAL Central middle- Poland Asia Income Development diamond* 1998 Population, mid-year (millions) 38.7 473 588 GNP per capita (Atlas method, US$) 3,900 2,190 4,860 Life expectancy GNP (Atlas method, US$ billions) 150.9 1,039 2862 Average annual growth, 1992-98 Population (%) 0.1 0.1 1.4 Laborforce(%) 0.8 0.6 2.0 GNP Gross Most recent estimate (latest year available, 1992-98) pit rimeny Poverty (% of population below national poverty line) 24 .. .l Urban population (% of total population) 65 8 77 Life expectancy at birth (years) 73 69 70 Infant mortality (per 1,000 live births) 10 23 27 Child malnutrition (% of children under 5) Access to safe water Access to safe water (% of population) .. .. 79 Illiteracy (% of population age 15+) 0 4 11 Gross primary enrollment (% of school-age population) 96 100 108 - Poland Male 97 101 /pper-middle-income group Female 96 99U d. KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1977 1987 1997 1998 EconomIc ratios* GDP (US$ billions) .. .. 147.9 157.5 Gross domestic investment/GDP .. .. 24.7 27.0 Exports of goods and services/GDP .. .. 25.7 20.7 Trade Gross domestic savings/GDP .. .. 20.4 18.7 Gross national savings/GDP .. .. 20.4 22.6 Current account balance/GDP .. .. -2.9 -4.4 Interest paymentslGDP .. .. 0.9 1.1 Domestic Investment Total debt/GDP .. .. 27.0 30.5 Savings Total debt service/exports .. .. 7.9 Present value of debt/GDP .. .. 24.2 Present value of debtlexports .. .. 110.7 Indebtedness 1977-87 1988-98 1997 1998 1999-03 (average annual growth) GDP .. 3.6 6.8 4.8 5.2 - Poland GNP per capita .. 3.5 6.7 5.3 5.0 Upper-middle-income group Exports of goods and services .. 13.5 12.2 9.2 8.4 STRUCTURE of the ECONOMY 1977 1987 1997 1998 Growth o not n (% of GDP) Agriculture 5.6 .. Industry 37.5 .. 20 Manufacturing 22.5 .. , Services 56.9 .. o__ 0 Private consumption 63.5 .. .r as 94 as 97 98 General government consumption 16.1 Imports of goods and services 30.0 .GD1 GDP 1977-87 1988-98 1997 1998 (average annual growth) Growth of exports and Imports (%) Agriculture . -1.0 0.6 .. 30 Industry 4.4 10.8 Manufacturing . .. .. 20 Services . . Private consumption . 4.2 6.9 4.2 General government consumption . 2.6 3.5 .. o Gross domestic investment . 8.9 20.8 14.1 03 e4 5 s 97 9 Imports of goods and services .. 18.8 21.4 17.9 - Exports os Gross national product .. 3.7 6.8 5.4 Note: 1998 data are preliminary estimates. The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond wiff be incomplete. 10 Annex A Page 2 of 2 Poland PRICES and GOVERNMENT FINANCE Domesticprice 1977 1987 1997 1998 Inflation (%) (% change) 0 Consumer prices .. .. 14.9 11.8 4o Implicit GDP deflator .. .. 14.0 12.0 s 20 Government finance (% of GDP, includes cunent grants) 0 Current revenue .. .. 24.1 23.0 93 94 95 96 97 98 Current budget balance .. .. -1.0 -0.7 Overall surplus/deficit .. .. -2.7 -2.4 GDPdeflator 0 CP TRADE 1977 1987 1997 1998 (US$ millions) Export and import levels (US$ mill.) Total exports (fob) .. .. 25,751 28,229 50o n.a. n.a. ..0,O0 Manufactures .. .. 20,040 22,905 30o Total imports (cif) .. .. 42,308 47,054 Food .. .. 2,894 2,968 20,000 Fuel and energy .. .. 3,710 2,964 10,000 Capital goods .. .. 6,485 7,356 o6 M Export price index (1995=100) .. .. 122 130 9 n 94 95 9 97 Import price index (1995=100) .. .. 126 129 WExports imrports Terms of trade (1995=100) .. .. 97 101 BALANCE of PAYMENTS 1977 1987 197 1998 (US$nAftns) Current account balance to GDP (%) Exports of goods and services .. .. 30,953 33,799 e Imports of goods and services .. .. 41,968 48,028 Resource balance .. .. -11,015 -14,229 4 Net income .. .. -458 -567 2 Netcurrenttransfers .. .. 1,150 1,942 o Current account balance* .. .. -4,312 -6,858 92 95 Financing items (net) .. .. 7,902 12,566 -4 Changes in net reserves .. .. -3,590 -5,708 -6 Memo: Reserves including gold (US$ millions) .. .. 20,670 27,382 Conversion rate (DEC, locallUSS) .. .. 3.2 3.5 EXTERNAL DEBT and RESOURCE FLOWS 1977 1987 1897 1998 (US$ nifions) Composition of 1998 debt (US$ mill.) Total debt outstanding and disbursed .. 42,603 39,889 48,093 IBRO 0 2,078 2,157 G:3,812 A:2,157 IDA .. 0 0 0 D:,8 :940 Total debt service . 2.060 2,562 IBRO .. 0 297 321 IDA .. 0 0 0 Composition of net resource flows Official grants .. 0 431 F: 1,1066 Official creditors .. -232 -140 E:23,016 Private creditors .. -246 934 Foreign direct investment .. 12 4,908 Portrlio equity .. 0 945 World Bank program Commitments .. 0 0 20 A - IBRD E- Bilateral Disbursements .. 0 239 153 B - IDA D -Other nUtilateral F - Private Principal repayments .. 0 155 174 C-IMF G- Short-term Net flows .. 0 84 -21 Interest payments .. 0 142 147 Nettransfers .. 0 -58 -168 Development Economics 9/22/99 * Includes unclassified transactions of $6.011 billion in 1997 and $5.996 billion in 1998. 11 Annex B Page 1 of 2 Basic Data Sheet Poland - Enterprise and Financial Sector Adjustment Loan (Loan 3599-POL) Key Project Data (amounts in US$ million) Appraisal Actual or Actual as % of estimate current estimate appraisal estimate Total project costs 450 325 78.2 Loan amount 450 Cumulative Estimated and Actual Disbursements (US$ millions) FY93 FY94 FY95 FY96 Appraisal estimate 0 325.00 450.00 450.00 Actual 0 75.66 224.96 324.39 Actual as % of estimate - 23.30 50.00 72.10 Date of final disbursement March 20, 1996 Project Dates Original Actual Identification (Concept Review) January 20, 1991 Preparation June 26, 1992 Decision Meeting September 23, 1992 Appraisal October 28, 1992 Negotiations January 19, 1993 Letter of Development Policy April 8, 1993 Board Presentation May 4, 1993 Signing October 11, 1993 Effectiveness June 1993 January 4, 1994 First Tranche Release June 30, 1993 June 6, 1994 DDSR Set-Aside 1994 November, 1994 Second Tranche Release December 31, 1993 Third Tranche Release June 30, 1994 NA Loan Closing June 30, 1995 June 30, 1996 12 Annex B Page 2 of 2 Staff Inputs (Staff Weeks) Stage of Project Cycle Planned Revised Actual Weeks US$ Weeks US$ Weeks US$ Preparation to appraisal 88.8 253,700 Appraisal 22.5 65,100 Negotiations through Board Approval 48.9 155,200 Supervision 223.9 697,200 Completion 9.0 46.5 Total 267.6 826.6 Mission Data Stage ofProject Cycle MonthlY No. of Days in Specialization' Performance Rating' Type of ear Persons Field Problems Implementation Development. Status objectives Identification 3/91 6 96 E,F Identification 12/9 1 4 40 E,F Pre-Appraisal 6/92 9 180 E,F Appraisal 10/92 7 70 E,F Supervision 6/93 4 44 E,F 1 1 M/T Supervision 2/94 3 36 E,F 1 1 M/T Supervision 2/95 3 27 E,F 1 1 M/T Completion 1/97 1 15 F 1. Specialization 2. Performance Rating 3. Types of Problem E = Economist 1 = Minor problems M = Managerial F = Financial Analyst T = Technical ANNEX C Key Macroeconomic Variables, 1990-98 DESCRIPTION Unit 1990 1991 1992 1993 1994 1995 1996 1997 1998 1994-98 Average Real GDP growth (0) .. -5.5 3.1 4.3 5.1 7.00 6.0 6.8 4.8 6.1 Price Change (CPI, %) 585.8 70.3 43.0 35.3 32.2 27.80 20.1 13.2 8.6 20.0 Current Account Balance $ Millions -1359.0 -269.0 -2868.0 677.0 5310.0 -1371.0 -4312.0 -6858.0 -1310.8 Net direct investment inflows $ Millions 117.0 284.0 580.0 542.0 1134.0 2741.0 3041.0 4966.0 2484.8 Net portfolio investment inflows $ Millions 0.0 . 0.0 0.0 -624.0 1171.0 241.0 2098.0 1330.0 843.2 Exchange rate (ZL/USD, average) 0.9 1.06 1.4 1.8 2.3 2.4 2.7 3.3 3.5 2.8 Unemployment rate (end ofperiod,%) 6.1 11.8 13.6 16.4 16 14.9 13.6 10.3 10.4 13.0 Source: OECD  14 Annex D Page 1 of 3 Comments of the Polish rovernment on the Audit REPUBLIC OF POLAND MINISTRY OF FINANCE Foreign Assistance Funds Department 12 9wiQtokrzyska Str. 00-916 Warszawa, Poland TEL No: (48-22) 694-37-37; 694-39-64, FAX: (48-22) 694-38-18; 826-03-00; 826-66-70 Date' 27', March, 2000 Nmnber of pages: 3 To: Mr Ruben Lamdany Manager, Country Evaluations and Regional Relations, Operations Evaluation Department The World Baik, Washington D.C, USA Fax No: 202/522-3124 From: Beata Nebrebecka IFO Division Head, Foreign Assistance Funds Dept. Fax No: 48-22/ 826-03-00 Copy: Fax No: Message: Re: Enterprise and Financial Sector Adjustment Loan (Loan No 3599-0 POL) Draft Performance Audit Report Dear Mr Lamdamy, Enclosed please find the letter signed by Mr Krzysztof J. Ners - Under-secretary in the MOF concerning the above mentioned draft of the PAR. Yours sincerely, Beata Nehrebecka IFI Division Head Foreign Assistance Funds Department Annex D Page 2 of 3 Warsaw, 2000.03. 15 MINISTRY OF FINANCE UNDERSECRETARY OF STATE KRZYSZTOF J. NERS OFN[F/tWi8%0io0 Mr. Ruben Lautdany Manager Country Evaluations and Regional Relations Operations Evaluation Department The World Bank Re: Poland: Enterprise and Financial Sector Adjustment Loan (Loan 3599- POL) Draft Performance Audit Report Dear Mr. Lamdany, Referring to your letter dated February 17, 2000 I have several comments on the above mentioned report: 1. I propose to change text of the article 3.10 in your document as follows: ,,Bank privatisadon proceeded more slowly than epected t was connected with the complicated process of the transformation of the Polish economy, for eample with bad loan problems. A lack of precision in the EFSAL legal documents deprived the Bank of a clear mandate to monitor the pace of privatisation. Also, finding strategic investors proved difficult By the EFSAL's second tranche, two of nine state-owned banks were privadsed, as agreed The remaining state-owned banks were prvadsed until 1999. The privatisation of banks accelerated the development of capital market and influenced changes in other sectors of the Polish economy". 2. In my opinion in Annex A of the report, there should be also included data for 1999. 3. Please correct on the front page of the document: incorirect exchange rate on 30.09.1999 - is 5.7091, should be 4.1141 and exchange rates in the table as follows: 1993 1994 1995 1996 1997 1998 is 2.9317 3.5579 3.6687 14J349 . 4.7467 14.9337 should be 1.8145 2.2727 2.4244 2.6965 3.2808 3,4937 Annex D Page 3 of 3 A. The Page 5: The economic growth in years 1994 - 1998 in the relation to 1993 (1993 100) is 34% and in the document there is marked average growth 6,1% and it's limited to years,1995-1998 without 1994. 5. Annex A page 1: * GDP (USS billions) in 1997 is 147,9 - should be 143,1 * GDP (USS billions) in 1998 is 157,5 - should be 157,3 * Gross domestic investmentIGDP in 1997 is 24,7 - should be 23,6 * Gross domestic investment/GDP in 1998 is 27,0 - should be 25,3 * export of goods and services[GDP in 1998 is 20,7 - should be 28,4 * Gross domestic savings/GDP in 1998 is 18,7 - should be 21,1 6. Annex C 1991 1992 1993 1994 996 1997 1998 GDlP% is . -5,5 3,1 4,3 -t GDP % should be -7,0 2,6 3,8 52 Current Account Balance -1.359,0 -269,0 is Current Account Balance -2.596,0 - 1.515,0 should be CP average is 20,1 13,2 8,6 CPI average should be 19,9 14,9 11,8 Sincerely Yours